As businesses and organizations in general come to depend on IT service providers for different types of IT services, the significance of SOC reporting has increased. This is mainly due to the heightened use of technology including social media, cloud computing, IoT and mobile technology, among others, which all present new hazards to be managed. Regulations are also more complicated these days and often necessitate organizations to demonstrate greater openness. Through SOC reports, organizations can deal with these difficulties by delivering assurance regarding their internal controls and enhancing communication between them, users and stakeholders. This eventually results in more trustworthiness and confidence in the risk management ecosystem.
The American Institute of Certified Public Accountants (AICPA) has released a couple of SOC options, and this has made it important to understand the difference between some of the more closely related SOC reports. SOC 1 and SOC 2 are some of the most common. But what is the difference between these two? Which one should you use?
Let's get answers to these questions, and more.
What is SOC?
SOC is an acronym for Service Organization Controls. This is essentially a framework provided by the American Institute of Certified Public Accountants (AICPA) for independent assessment and reporting on the effectiveness of the controls that an organization has in place to protect systems and data. The SOC is designed to provide reasonable assurance that systems are free from material misstatement, whether due to fraud or error.
SOC is framed as a suite of audit services that Certified Public Accountants (CPAs) can offer by evaluating and reporting on the system-level controls of service organizations and entity-level controls of other organizations. There are 3 categories of SOC:
1. SOC for service organizations
These are internal control evaluations on the services provided by a service organization. They provide important information that helps users to understand the risks associated with outsourcing services to an organization. This category contains SOC 1, SOC 2, and SOC 3.
- SOC 1: Designed to meet the needs of users who need assurances about the impact of a service provider's internal controls on their financial statements and procedures.
- SOC 2: Designed to meet the needs of users who want assurances about the security, availability, processing integrity, confidentiality and privacy of the systems the service provider uses to handle users' data.
- SOC 3: Designed to meet the needs of users who want general assurance about the security, availability, processing integrity, confidentiality and privacy of a service provider's systems. The type of users who demand SOC 3 normally don't have the need for SOC 2 or lack the necessary knowledge to make a comprehensive use of SOC 2.
2 .SOC for cybersecurity
This is a framework that service organizations can use to showcase the strength of their cybersecurity management systems. CPAs audit and report their findings to a wide range of interested users.
3. SOC for supply chain
This is a framework used to report on the effectiveness of an organization's controls for the production, manufacturing or distribution of goods. The goal is to understand the extent of risks along the supply chain.
SOC reports explained
A SOC report is a presentation of the findings of an evaluation conducted by a SOC accredited, independent CPA firm, regarding an organization’s internal controls under any of the SOC options above. Depending on the type of SOC framework that the auditors have been invited to perform, they can prepare a SOC 1 report, SOC 2 report, SOC 3 report, SOC for cybersecurity report or SOC for supply chain report.
For purposes of this guide, we’ll stick to SOC 1 and SOC 2 reports.
What is SOC 1 report?
SOC 1 report gives findings about how a service provider's internal controls impact the financial processes of their clients. There are two types of reports under SOC 1:
Type 1: Type 1 reports on the level of fairness of how the service provider's system has been presented by management — is it a fair representation of how the internal controls affect the financial statements? It provides detailed information (description) regarding the design of the controls at a service organization on a given date.
Type 1 report also gives a position on whether the way the controls are designed is suitable enough to achieve the control objectives outlined in the description as of the specified date. So the report will for example, answer the question: «Were the controls in place capable of achieving the objectives as at the 31st of December, 2022?»
Type 2: SOC 1 type 2 reports on the level of transparency of the management's description of the system as well as whether the controls are designed in a way that they are effective enough to achieve the objectives outlined in the description covering a specified period of time. So the SOC 1 type 2 report will answer the question: «Were the controls in place capable of achieving the objectives during the period 1st January 2022 to 1st July 2022?»
In other words the clear cut difference between type 1 and type 2 reports is that type 1 report addresses the transparency and effectiveness of the controls as of a specific data; whereas type 2 addresses the effectiveness of the controls during a specified period.
What is a SOC 2 report?
SOC 2 report outlines the controls of a service organization according to the 5 Trust Services Criteria (TSC) established by the American Institute of Certified Public Accountants (AICPA). The five TSCs include:
- Processing Integrity
So the SOC 2 report gives findings about a service provider’s controls around security, availability, processing integrity of the systems the service provider uses to process users' data, as well as the confidentiality and privacy of the information that these systems process.
The security criteria is the only one of the Trust Service Criteria that is required to be included in a SOC 2 report. This is why the security component is usually referred to as the common criteria. In other words, a service organization can opt to have a SOC 2 report that concentrates on just security/common criteria, all the five criteria, or some combination of the security criteria and just a few of the others.
Just like SOC 1, SOC 2 also has type 1 and type 2 reports. SOC 2 type 1 report focuses on the suitability of the controls’ design to meet the objectives described as of the specified date. Soc 2 type 2 focuses on the operational effectiveness of the controls’ design during a specified period.
SOC 2 reports can be used for vendor management, regulatory oversight, internal corporate governance & risk management. These reports are restricted as they deal with aspects of data.
Generally speaking, both SOC 1 and SOC 2 type 2 reports should cover a minimum of 6 months, though there may be exceptions to this depending on the situation. However, it's best to aim for a period of 12 months where possible.
If you need to quickly issue a report to a prospect, the Type 1 report is your best bet. This ensures that the report shows you have efficient controls in place as of the specified date.
The main difference between SOC 1 and SOC 2 reports
The primary difference between SOC 1 and SOC 2 reports is the type of control objectives they focus on. SOC 1 Reports focus on financial controls while SOC 2 Reports focus on security, availability, processing integrity, confidentiality, and privacy controls.
Here is a summary of the differences;
|Difference||SOC 1||SOC 2|
Focuses on a service organization’s internal controls relating to financials.
Focuses on a service organization’s internal controls relating to data processing, integrity and privacy
The controls are tested based on objectives.
The controls are tested based on AICPA’s 5 Trust Services Criteria.
Classified under the Statement on Standards for Attestation Engagements (SSAE) 18 standard, section AT-C 320 (previously known as SSAE 16 or AT 801).
Classified under the Statement on Standards for Attestation Engagements (SSAE) 18 standard, sections AT-C 105 and AT-C 205
Choosing the criteria
The service organization works with auditors to brainstorm the essential control objectives for the services they provide to their clients.
Besides the security criteria which is required across the board, the service organization is free to choose which other trust criteria are relevant to its services and compliance requirements.
Who uses the report?
Those who might find the results of the SOC 1 report useful include financial executives in the user organization, financial auditors from the service organization, or compliance officers.
Those who might be interested in the SOC 2 report include compliance officers, financial executives, auditors, IT executives, regulators, and partners.
A word on SOC control guidelines
Service organizations have some level of flexibility around the controls to include in a SOC report. SOC 1 has no stipulated criteria, but there has to be clear control objectives that are linked to the services offered. Let's say one of the objectives is to control access to the server room. Some of the controls that an organization can implement to meet this objective could include using biometrics.
For SOC 2, AICPA has a clear criteria that auditors will use to test the controls. But again the organizations have some room to be flexible on the controls they need to have in place in order to meet the criteria. For example, if an organization is keen to meet the TSC criteria on availability, some of the controls that the organization might put in place could include having redundant systems or having a tested disaster recovery plan.
Also Read: Best practices for disaster recovery testing
When is a SOC 1 report necessary?
SOC 1 reporting is necessary when an organization or other stakeholders want to be assured that the service organization has sufficient controls in place to guarantee effective controls over financial reporting processes. The report will assess the internal controls of a service organization that are most relevant to financials. That could be controls over the data center, payroll processing, customer account management, or any other area where information flows into the financial statements.
The report is meant to give stakeholders confidence that the organization has effective controls in place to protect the accuracy and completeness of its financial reporting. The report is typically prepared by an independent accounting firm, and it is based on an evaluation of the organization's controls on a specified date (type I report) or over a period of time (type II report). The report is usually required by regulatory agencies, banks, and other financial institutions. It can also be requested by customers or other stakeholders who want assurance that the service organization has adequate controls in place.
When is a SOC 2 report necessary?
SOC 2 reporting is necessary when an organization wants to report on the design of controls, as well as the effectiveness of those controls, that are relevant to the the 5 Trust Service Criteria i.e. security, availability, processing integrity, confidentiality and privacy. The report is also necessary when an organization wants to communicate its compliance with the American Institute of Certified Public Accountants (AICPA) Trust Services Principles. Existing and prospective clients can also ask for this report, as well as other compliance bodies.
Any business that handles sensitive data should give serious consideration to obtaining a SOC 2 report to constantly provide assurance that they have adequate internal controls to protect the security, integrity, availability, confidentiality, and privacy of customer data.
Although there is no legal obligation to obtain these reports, they are more frequently being requested by various groups. Clients, whether new or existing, may demand assurance that a service organization has implemented stringent controls to protect their operations. Stakeholders can use these reports to ensure their interests are adequately protected. Furthermore, certain compliance entities may require these reports as part of their stipulations, depending on the industry.
It's clear to see how essential these reports have become; not taking them seriously can put a service organization at a serious disadvantage. Plus, some industries, such as healthcare and finance, may require the use of SOC-compliant service providers. Obtaining the reports is a worthwhile investment — it'll improve your company's image, make it easier to convert potential clients and give you a good reputation among stakeholders and industry regulators.